US corporate profits in 2018 have been growing at the fastest pace since 2010, but that rate is unlikely to continue in 2019. Rising input costs, a tight labor market and gradually tightening financial conditions all point to the later stage of the business cycle.

Analysts’ lower expectations on 2019 growth were one of the driving forces behind the October and November selloffs. Companies missing earnings expectations were punished more than average, while beats were rewarded less, underscoring increasing concerns that we have passed peak growth.1 From a valuation perspective, with declining growth prospects, investors have been unwilling to pay for stocks’ lofty valuations, evidenced by high Book-to-Price stocks underperforming low Book-to-Price stocks by 3.6% since the start of Q3.2

This is not to say we expect an imminent economic contraction. Corporate earnings probably will grow in the high single digits in 2019. And the tight labor market and potential for more fiscal stimulus, such as a bipartisan infrastructure bill, may support domestic demand. Nevertheless, as economic growth decelerates, downside risks have increased due to tightening monetary policy, weakening global growth and prolonged trade tensions.

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Source: FactSet, as of 11/16/2018

Pursue quality at reasonable valuations

Against this backdrop, adding more quality companies with high profit margins and healthy balance sheets at a reasonable price may provide more resilience and cushion some downside risks. And blending differentiated factor exposures may create a more balanced profile to navigate this downhill climb. As shown below, the MSCI USA Factor Mix A-Series Capped Index—a blend of quality, value and minimum volatility factors—stood strong during the October and November selloffs, providing a smoother return path than single factors.

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Source: Bloomberg Finance L.P., as of 11/20/2018. Past performance is not a guarantee of future results. MSCI USA Minimum Volatility Index, MSCI USA Enhanced Value Index, MSCI USA Quality Index, MSCI USA Equal Weighted Index, MSCI USA High Dividend Yield Index and MSCI USA Momentum Index were used above compared to the MSCI USA Index. Index returns are unmanaged and do not reflect the deduction of any fees or expenses.

Finally, as Benjamin Graham observed, "One of the most persuasive tests of high quality is an uninterrupted record of dividend payments going back over many years." Our research also shows that long-term dividend growth companies exhibit higher quality traits in terms of higher profitability, stronger balance sheets and less earnings variability than pure high dividend companies.3 As shown below, these higher quality traits have translated into persistent outperformance over the broad market, as well as high dividend yield strategies, when the broad market was down.

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Source: Bloomberg Finance L.P., for the period from Q1 2006 to Q3 2018. Past performance is not a guarantee of future results. Index returns are unmanaged and do not reflect the deduction of any fees or expenses.

Implementation ideas

Seek companies with high profit margins and healthy balance sheets that trade at reasonable valuations.

  • SPDR® S&P Dividend ETF (SDY)
  • SPDR MSCI USA StrategicFactorsSM ETF (QUS)

Consider rotating into more defensively oriented quality sectors with attractive valuations.

  • SPDR S&P Pharmaceuticals ETF (XPH)
  • Consumer Staples Select Sector SPDR Fund (XLP)
  • SPDR S&P Bank ETF (KBE)

Follow SPDR® Blog to see our next strategic theme for tackling 2019, ‘get defensive in bonds.’ You can also follow the whole 2019 Market Outlook series here.

1FactSet, as of 10/31/2018.
2State Street Global Advisors, Bloomberg Finance L.P., as of 10/31/2018. Based on Quintile 1—Quintile 5 of Book-value-to-price factor where quintile 1 has high B/P stocks and quintile 5 has low B/P.
3"Fundamental Quality Characteristics in Dividend Strategies", May 2018, Daniel Ung, State Street Global Advisors.


Earnings Per Share (EPS)
A profitability measure that is calculated by dividing a company’s net income by the number of shares outstanding.

One of the six research-based smart beta factors that refers to “quality” equities. Quality companies are those whose stocks exhibit consistent profitability, stability of earnings, low financial leverage and other characteristics, such as ethical corporate governance, that are consistent with long-term reliability.